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IT USED TO BE SIMPLE. Those who had worked long and hard and had saved and invested prudently could pick up the gold watch, clean out the desk, say goodbye to the office and depend on certificates of deposit and U.S. Treasury securities to provide a substantial part of their post-retirement income. But these days, they need a new game plan. With yields near historic lows, Treasuries simply aren't cutting it as the mainstays of income portfolios, and rates on bank CDs are pitiful. The yield on a standard laddered one- to 10-year Treasury-bond portfolio is a skimpy 1.5%. On a $500,000 investment, that's $7,500, or $4,875 after income taxes at the highest marginal rate. Worse, many folks are sitting in ultra-short Treasuries and money-market funds with sub-1% yields.

Paltry payouts may have been bearable in exchange for liquidity and credit quality at the peak of the credit crises, when economic uncertainty was extreme. But now, with a recovery under way, default rates way down, and capital flowing, strategists say investors can do much better. Yields of 5% to 7% are attainable in assets such as emerging-market debt, senior bank loans and master limited partnerships, says Tony Roth, the head of wealth planning and investment strategies at UBS Wealth Management. Of course, investing for higher yields almost always means taking on more risk, he warns, "so we're recommending a combination of strategies."

Meanwhile, many investors in U.S. Treasuries and corporate bonds—for generations, among the most stable investments—might be underestimating their risk.

Since the start of 2010, $274 billion has poured into bond funds, while $35 billion has been pulled out of stock funds. The Federal Reserve's plan to pump $600 billion into the economy by next summer may keep rates down for six to 12 months. But when rates climb, the underlying values of bondholders' securities decline as demand shifts to higher-yielding issues. A 50-basis-point rise in rates—there are 100 basis points in one percentage point—could deal as much as a 9% blow to principal to folks in longer-term bonds, assuming that the holders sell them before they mature. The longer the maturity, the more severe the impact from rising rates.

"The world is topsy-turvy where risks are aligned," says John Tousley, vice president and portfolio strategist for third-party distribution at Goldman Sachs Asset Management. Contrary to what many investors assume, he says, "seeking more credit and global fixed-income exposure" will reduce the risk in an income portfolio, while adding diversification.

There are lots of higher-yielding alternatives to government and corporate bonds, but before plunging into them, investors should weigh what role each can play in their portfolios, says Andy Sieg, Bank of America Merrill Lynch's head of retirement services. Consider your income portfolio as made up of two buckets, he suggests: One to cover immediate and unavoidable expenses for the next four to five years; the second, geared toward generating income for longer-term, less critical expenses.

Volatile and riskier investments should populate the second bucket. In the first, play it very safe. Right now, that means aiming for a yield above 1%. That might not seem like a high hurdle—in fact, a yield like that would have been considered pathetic a decade ago. But the depressing reality is that average yields now are 0.03% on money-market mutual funds and 0.16% on three-month Treasuries. Bank money-market accounts offer more—0.65% to 0.94%, on average, depending on the size of the deposit.

But you can do better. American Express Bank is currently offering a 1.3% yield; WT Direct, a unit of Wilmington Trust, 1.21%. Ultra-short bond funds also offer somewhat higher yields, but they will temporarily swoon if interest rates rise, "so think of them as your second layer of liquidity for expenses nine to 12 months away," says Matt McGrath, a financial advisor in Coral Gables, Fla. Also, keep an eye on their underlying investments. During the credit-market collapse, many investors were battered by seemingly safe ultra-short funds that turned out to have significant exposure to toxic mortgage-backed securities.

The bottom line for income investors? Finding yield is tough, but there are still ways to generate a decent stream of cash, while tempering risk by keeping maturities to three years or less.

Consider the following:

EMERGING-MARKET DEBT:

Bonds issued by emerging nations and denominated in local currency are the global fixed-income market's current sweet spot. These securities are tracked by the JPMorgan GBI EM Global Diversified Index, which has a 6.2% yield, says Jamie Kramer, global head of thematic advisory at JPMorgan Private Bank. "We strongly believe that the dollar will continue a secular decline and emerging-market currencies will appreciate," she says. "So you not only get more yield, you get currency appreciation too."

Kramer sees a far better outlook for this debt than for any other global debt, even though holders take on rate and currency risk and possibly government-stability risk, too.

To be sure, this asset class is three times as volatile as the Barclays Capital U.S. Aggregate Bond Index. But for anyone seeking to generate longer-term income, volatility should be less of a concern, Kramer asserts, especially because the fundamentals and growth prospects are solid.

She notes that emerging nations' debt, on average, equals about 33% of gross domestic product, versus 100% for the developed nations. And, she adds, GDP is expected to rise 5.6% annually in the developing nations, compared with less than 2% in the developed ones. "Finally, if you think about the allocation of institutional money, right now it's underallocated in emerging-market debt and equity," she adds. When more institutional money comes in, early investors should benefit from a rising tide.

FOREIGN GOVERNMENT BONDS

Debt crises in Ireland, Greece and elsewhere certainly have made some retirees unwilling to put their money into these securities. But these bonds, when prudently selected by an experienced fixed-income mutual-fund manager, can dramatically boost yields over what is produced by U.S. government paper, says Steven Enright, an advisor in River Vale, N.J.

For example, one-year bonds issued by the government of Australia recently were yielding 4.68%, compared with 0.28% for one-year bills offered by Uncle Sam. "You're getting nothing in certificates of deposit or Treasuries, so you do have to take some risk—going global involves measured risk," Enright says, adding that many global mutual funds yield 4% to 5%.

HIGH-YIELD CORPORATE BONDS

The lowest-hanging fruit on the junk tree has been picked, but current yields, around 6%, factor in higher default rates than are likely, strategists say. "There are some companies like
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(ticker: CVC) and
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N/AMarket Cap
4340199872.82882
Dividend Yield
11.336032388663968% Rev. per Employee
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(FTR) that aren't investment-grade because of their debt levels, but have very strong cash flows, and thus the ability to pay their debt," says Ronald Deutsch, a managing director at Sage Capital Management in New York.

If interest rates rise, the big risk premiums on high-yield bonds can cushion some of the blow, Kramer says. "As long as you choose a manager who does fundamental bottom-up research and looks at the quality of the bonds, if you get a 7% yield and lose 3% from duration, you still get 4% without figuring in any spread compression."

BUILD AMERICA BONDS

As an alternative to corporate bonds, consider the higher yields on Build America Bonds, which are taxable municipal bonds, created under the American Reinvestment and Recovery Act to help states and municipalities borrow at a discount. Issuers get a 35% federal subsidy on the interest paid for the life of the debt.

"You can find bonds without big premiums, strong credit ratings and good long duration," says John Dillon, chief municipal- bond strategist at Morgan Stanley Smith Barney Capital Markets. And, he adds, "you can pick up a 20-basis- to well over 100-basis-point spread over corporate yields."

Liquidity may be a problem with these securities, however. The market is small—$160 billion, compared with the $2.8 trillion overall municipal-bond market—and the program expires at year end. Congress may extend it. But if it doesn't, "there's a potential for reduced liquidity down the road," Dillon acknowledges. He recommends buying larger issues because they presumably will have better liquidity. Alternatively, you can simply plan to hold the bonds until maturity.

SENIOR BANK LOANS

One of the rare fixed-income products with little interest-rate risk, senior bank loans are paying investors upward of 6%. These are loans made to non-investment- grade commercial borrowers. Their yields reset every 90 days, so they will be able to keep pace if interest rates start rising, says Greg Stoeckle, manager of the
Invesco Floating Rate Fund
(AFRAX).

These loans come with somewhat less credit risk than high-yield bond funds because they have senior status in a company's capital structure. If the borrower defaults, the issuer of the senior bank loan is first in line to be paid.

In 2008, the index had an unprecedented drop of 30% when the credit markets collapsed and major broker-dealers pulled back their trading capacity. "But the leverage that contributed to the massive selling pressure is out of the system and the major broker-dealers that participate in this market have repaired their balance sheets," Stoeckle says. Default rates, which peaked at 10.8% in 2009, are now below 3%. Investors can get into senior bank loans through floating-rate mutual funds like Stoeckle's.

MASTER LIMITED PARTNERSHIPS

Despite environmentalists' concerns, consumption of fossil fuels is likely to rise over the next decade. So income investors stand to benefit through partnerships that own and run key parts of the global energy infrastructure, such as petroleum processing plants, oil refineries and natural-gas pipelines. Like a toll booth on a turnpike, these entities, called master limited partnerships, keep collecting payments that aren't affected by swings in the price of oil. The current yield on the Alerian Index of MLPs is 6.6%.

DIVIDEND-PAYING STOCKS

The average yield on Standard & Poor's 500 companies that pay dividends is 2.45%—not exactly a windfall, but if you isolate sectors such as telecom, utilities and health care, you're looking at average yields of 6.1%, 4.6% and 3.3%, respectively, says Howard Silverblatt, Standard & Poor's senior index analyst.

After 2009 became the worst year on record for dividends, yields are likely to improve, he says. Last year, 78 companies in the S&P 500 index lowered their dividends, reducing payouts to investors by a net $40 billion. This year, only four companies have reduced their dividends, and total payouts have increased by $17.3 billion, he says, adding, "It will take a while to get back to where we were before 2008, but we are on the way."

Higher taxes on dividends are possible. If the Bush-era tax cuts expire next year, as scheduled, payouts could be taxed at rates on ordinary income, up to 39.6% instead of today's 15%. But, Silverblatt predicts, given the low levels of interest being paid by bonds, dividends will still look attractive to income investors, even those who are in highest income-tax brackets.

However, investors who load up on dividend-paying stocks take on more volatility, too. "Dividend stocks go down when the market goes down," says Chris Wolfe, chief investment officer at Merrill Lynch Private Bank and Investment Group. "Investors have to go back to their overall allocation to make sure they don't go over acceptable risk levels–if they use more equity income, they have to favor a little more bonds to balance out the risk."

VARIABLE ANNUITIES

For a lifetime income stream, consider a low-cost variable annuity, says Mark Cortazzo, an advisor at Macro Consulting Group in Parsippany, N.J. But it's important that the annuity have a guaranteed minimum payment. The assets underlying the annuity are invested in the stock market, so this will prevent the payment from going too low if stocks crater. On the other hand, if they rise, the payment will get bumped up. (There can be a cap on how high it can go.)

In contrast, an immediate annuity locks in a fixed payment for life, but gives you no chance of a raise, unless it carries an inflation-adjustment rider, which can be costly.

A plain-vanilla immediate annuity, Cortazzo says, "may start out with a somewhat higher payment, but you lock in a payment based on historically low interest rates and give away all of your upside."

He favors variable annuities with short surrender periods, so that if interest rates rise but the stock market doesn't, you can move your money to a different, higher-paying annuity without penalty.

MUNICIPAL BONDS

Finally, there's that old standby, the municipal bond, which has fallen out of favor lately because of worries about the finances of the U.S. states, localities and agencies that issue them. This, as Barron's pointed out recently ("Swimming for Shore," Nov. 22), has created a buying opportunity, with prices down and rates on some investment-grade munis exceeding 6%.

Many strategists favor revenue bonds, which are munis backed by the money collected by essential public agencies, such as those that run municipal water companies or oversee toll roads. "There's some concern about the creditworthiness of general-obligation munis," says Sage Capital's Deutsch. "But people have to pay water bills and tolls."

Thanks to market shifts, closed-end muni funds have become more attractive, too. "Many are trading at discounts again" from the value of the bonds in their portfolios, Deutsch observes. One example:
Alliance New York Municipal
Fund (AYN), yielding 6%, and offering a big tax break to New York state residents. The fund was trading at a premium two months ago. Now it changes hands at a 4% discount.